Mom’s Attempt to Deduct Basement Office Expense, Wages to Children Falls Flat

A businesswoman’s attempt to maximize her business expense deductions ultimately went too far, according to a recent US Tax Court ruling. The court decided that the woman did not have sufficient basis for claiming that one-third of her home was deductible office space, and that the facts of her case did not support her claim that she paid compensation to her three minor children.

Patricia Ross carried on multiple business ventures in 2007 and 2008, some of which she ran from the basement of her home. The businesswoman also put her three children, ages 15, 11, and 8, to work for one of her businesses. The children performed tasks such as stuffing envelopes, shredding paper, copying, filing, and carrying equipment.

The IRS declared a $3,000 deficiency in Ross’ 2007 return, and $7,300 in 2008. The court took issue with several aspects of the taxpayer’s return. One element the IRS had challenged was Ross’ home office expense deduction. On her return, Ross declared the size of her business space to be “33” and her home’s total size to be “100.” The court guessed that the taxpayer essentially declared one-third of her home as her business space based upon the total number of floors in the house (presumably, the basement and two above-ground floors). This method was not acceptable. The court explained that, in order to arrive at the correct portion of the home specifically dedicated to the business, and subject to the deduction, a taxpayer should typically either divide the number of rooms devoted to the business by the total number of rooms (if all rooms are of nearly equal size), or divide the number of square feet dedicated to the business use by the home’s total square footage.

Ross’ 33 and 100 responses clearly did not refer to square footage or number of rooms. In fact, based upon the evidence presented, the court could not determine what the basis was for Ross’ claims. Without an adequate basis to base an estimate of the size of the home office, Ross was not entitled to the deduction at all.

The taxpayer’s wages she paid to her children also did not pass muster. Wages or other compensation, in order to be deductible, must be of a reasonable amount, be the result of actual services performed, and be actually paid. A parent may deduct wages paid to a child, but these deductions are scrutinized especially closely by the IRS and the courts.

In Ross’ case, the evidence seemed to show that the money she spent on the children’s behalf was not actual wages paid. One of the facts least favorable to the taxpayer was the lack of correlation between the hours a child worked and the amount she was “paid.” The oldest child received $132 in January 2008 for 39 hours worked but was later paid $515 in May for only 20 hours worked. “The lack of correlation between the dates and amounts of payments and the hours allegedly worked by the children militates against the deductibility of the payments,” the court concluded.

The tax code permits taxpayers, especially independent businesspeople, many opportunities to deduct many of the expenses they incur. The keys to success often involve understanding the bounds of these deductions and adequately documenting the deductions claimed. For advice about how the tax code can affect and benefit your small business, reach out to the tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.

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